The Philosophical Investor

Transforming Wisdom into Wealth

Gary Carmell

• Publisher: Greenleaf Book Group Press
• Year: 2015
• ISBN:
  9781626341708
• Topic: Personal Development
• Subtopic: Personal Finance

Gary Carmell, real estate visionary, explains how to profit from “tectonic shifts” in the economic landscape. With almost thirty years of success in the fast-moving real estate investment industry, Gary Carmell has seen his company’s assets multiply tenfold over the last three decades. In The Philosophical Investor: Turning Wisdom into Wealth, he shares with readers how careful study of trends, attention to history, and even literature and philosophy have helped his firm chart a profitable course, even during the Great Recession of 2007–2009. Correctly anticipating economic trends has allowed CWS Capital Partners LLC, Carmell’s real estate investment and management firm, not only to generate impressive gains but also to produce long-term average annual returns exceeding 13 percent for its loyal investors. Navigating such turbulent economic seas and experiencing his two-year-old son’s near-fatal stroke has taught Carmell that real success requires not only financial acumen, but also deep reflection. He credits Shakespeare, Hume, and Schopenhauer as his mentors, with more modern sages like Buffett, Soros, and Munger. In The Philosophical Investor: Turning Wisdom into Wealth, he shares the insights he has gained along the way.

INTRODUCTION

The practical philosopher transforms ideas into life; he acts, therefore, in a thoroughly reasonable manner; he is consistent, regular, deliberate; he is never hasty or passionate; he never allows himself to be influenced by the impression of the moment. The theoretical philosopher enriches the domain of reason by adding to it; the practical philosopher draws upon it, and makes it serve him.

—Arthur Schopenhauer

I have worked in the world of investments for nearly thirty years with the same firm, CWS Capital Partners. Our focus has been in real estate, first manufactured housing communities (1969–1998) and then apartments beginning in 1988. We started winding down our emphasis on the former in the early 1990s as we began concentrating almost exclusively on the latter during the same period. While our focus on a particular industry may have been very specific versus that of a stock market investor deploying capital in many companies operating in a wide range of industries, I am confident that the lessons learned have been universal: applicable to any serious investor or thoughtful person who finds great rewards in following the advice of the Oracle of Delphi to “know thyself.” Owning these businesses directly and controlling their cash flows and personnel decisions—rather than participating through passive ownership interests—has afforded us invaluable experience.

The most important lesson I have learned over my career is that “Shift Happens” (tectonic shift, that is) and that we can either monetize these shifts (increase wealth and/or vital experience) or let them inevitably monetize us (we lose money and/or take very little from the experience). Or, said differently, these shifts can catalyze tremendous personal growth (including financial growth) or be sources of great regression and stagnation if we don’t rise to meet the challenges or if we were not able to avoid them in the first place.

I think of tectonic shifts as massive changes that alter the trajectory of an industry or one’s life. Some can hit in an instant, like the earthquake and tsunami that decimated the Japanese nuclear energy industry virtually overnight in 2011. Such instant shifts can also be deeply personal, as when my son was two years old in 1995 and suffered a massive stroke, an event that has changed our family members’ lives forever.

The more typical pattern, however, is for stresses to build up over time and then implode when the foundation can no longer hold. Examples of these include the subprime lending debacle (2002–2009) and, something that hit very close to home for my firm, the collapse of the manufactured housing industry after 1998. By anticipating tectonic shifts or having the resiliency to courageously respond to them with the appropriate action when they occur, the philosophical investor can generate great wealth and avoid significant losses.

Our lives are much like nature and the financial markets. Most of the time, they plod along from day to day with nothing out of the ordinary taking place. There are those rare times, however, when in an instant something transpires that can change the course and trajectory of our lives by impacting our physical well-being, our careers, our relationships, those we care for, or our financial resources. In some cases more than one of these will be impacted simultaneously. These tectonic shifts can be sources of great pain, suffering, frustration, and exasperation for those who find themselves ill prepared for the event or without the resilience to bounce back. At the same time, for the small minority that either anticipated it or can recover far ahead of the pack, such an event can represent tremendous opportunities and building blocks for greater strength, meaning, and wealth creation. As Epictetus said, “It’s not what happens to you, but how you react to it that matters.”

I have found that a philosophical framework is critical in helping me take a step back away from the cacophony of conventional wisdom and all of the corresponding “thou shalts” and to merge onto the proverbial road less traveled. Choosing this path not only suits my more solitary nature, but I believe it also improves my chances of identifying what tectonic shifts might be forming and when they may occur. I am more able to reflect and respond thoughtfully instead of reacting impulsively, creating more clarity and vision.

I do not want to give the impression, however, that I am immune to the same powerful psychological forces creating the prodigious blind spots and suboptimal decision making that most people fall prey to. This is not the case at all. Rather, I hope to show in this book where I have failed, the lessons learned from my mistakes, and how these lessons were subsequently reapplied much more successfully. The real education for the reader will come, I hope, from learning about the specifics of the journey, struggles, failures, successes, heartaches, and rewards.

As someone said to me once, it’s better to be a meaningful specific than a wandering generality. It is my hope that the specifics of my journey will be far more interesting and informative than merely espousing general theories. I believe that only through experience, trial and error, and observation can we begin to discern patterns that can be formed into more general theories and postulates. This is a book that moves from micro to macro.

While most investment books are written with the complete benefit of hindsight, I have always been more fascinated by what decision makers were thinking in real time: in particular, what psychological forces they were up against in the face of imperfect information and powerful incentives and constraints. Unfortunately, with the possible exception of George Soros’s Alchemy of Finance, I cannot think of many other books that take such an approach. One non-book that nevertheless provides a real-time source of deep, in-the-moment wisdom has been Warren Buffett’s letters to his shareholders. I have read every one of them going back to 1956, and his writing style and what he communicates have been very influential to me over the years. I have been writing quarterly letters to our investors since the late 1990s as well as annual report letters and communications related to the specifics of individual investments within our portfolio. It is a large body of work, and this discipline has been quite helpful to me for organizing my thoughts to convey how we were viewing the environment at the time and to explain our outlook for the future. It also had the added benefit of going on record with our predictions, for which we could be held accountable. Equally important, these written communications have allowed us to go back and learn from our mistakes and successes.

Another one of my personal interests is to read old newspaper articles, particularly from the 1920s and 1930s. I see so many parallels between then and now, and these historical snapshots have helped me understand what was happening in real time, without hindsight bias. You will see how I relied heavily on this source material to help put the pieces of the puzzle together in the midst of the Great Recession to aid us in identifying what would happen with jobs, interest rates, real estate capitalization rates, and the growth in our operating income. This was hugely influential for us in terms of giving us the confidence that interest rates would not rise despite massive government spending, that jobs would materialize more quickly than most people thought, and that apartments were going to be very lucrative investments.

For most of us, the Great Recession was one of the most significant financial tectonic shifts in our lives, rocking the global economy and financial markets from 2007 through 2009 with the loss of trillions in wealth and millions of jobs. Although not immune to the negative effects of the worst downturn since the Great Depression, CWS was strong enough to be able to go on offense starting in late 2010 to embark on what we believed would be one of the greatest investment opportunities in a very long time. This book will show how we were prepared for this opportunity—one that I call a “Munger Moment,” named after Charlie Munger, Warren Buffet’s partner at Berkshire Hathaway (more about this later)—and took advantage of it.

Simplistically, I believe we at CWS are hypothesis generators in that we must have a reason or set of reasons as to why we think a particular investment will perform well over the years. After we make the purchase it is then up to us to keep testing the hypotheses and monitoring the results to see if our premises were accurate or flawed. It is my intention with this book to tap into some of the material I wrote in the past along with my current thoughts to show what we were thinking and the decisions we were making when it came to anticipating and/or reacting to some very powerful tectonic shifts. These decisions included

• exiting the manufactured housing business between 1998 and 2000, just prior to its long-term collapse;
• transitioning into the apartment business at a time when single-family home demand was exploding and the demand for rentals was diminishing;
• making a terrible decision to use fixed-rate financing with cost-prohibitive prepayment penalties at a time when interest rates were dropping and revenues were declining, and subsequently having to ask our investors to put more money into their investments;
• navigating through the subprime debacle and anticipating its impact on our apartment business;
• capitalizing on an extraordinary opportunity for apartment investors to capture the tremendous rewards accruing to those taking advantage of the transition to more of a renter nation (CWS’s Munger Moment); and
• dramatically changing our financing strategy to emphasize variable-rate loans: why we did this, and the financial benefits that we have reaped as a result.

I also intend to convey how important partnering with extraordinary individuals has been in all aspects of my life. I am convinced that the tremendous gifts and abundance that have been bequeathed to me would not have materialized had I not been blessed with my business partners Steve Sherwood, Bill Williams, and Mike Engels and a life partner beyond compare in my wife Roneet. Through these partnerships we have collectively been able to anticipate and/or react to powerful tectonic shifts that have generated tremendous growth for CWS, for my family, as well as for me personally. These include the aforementioned strategic decisions we made with our business to exit one form of real estate prior to its implosion and enter into another more lucrative area that has paid tremendous dividends for our investors. And from a personal perspective, the experience my wife and I had regarding my son’s stroke and a lifetime of residual issues, the unconventional decision we made with regard to our daughter’s schooling, and two important investment decisions that were personal Munger Moments for us have been deeply impactful tectonic shifts in our lives. They have resulted in us crying together, strategizing with one another, thinking creatively, laughing, taking risks, enjoying immense rewards, and living a deeply interesting and fulfilling life that has been a fascinating journey for which I look back in amazement and awe. I am one lucky person to have such a beautiful, smart, canny, and insightful woman leading the charge in our relationship and for our family.

I will also show why I think apartments still offer a wonderful investment opportunity for a number of years to come, some of the ways to evaluate whether an investment management firm is right for you, and what Shakespeare has taught me about knowing myself and others. The books ends on a personal, philosophical note that highlights some of my reflections on what constitutes true wealth—much of which is not strictly financial in nature.

This is a story about a unique individual (that would be me: a legend in my own mind!) and an extraordinary firm, CWS Capital Partners, which over the course of nearly thirty years has grown from approximately $250 million in assets in one form of real estate—manufactured housing communities—to over $3.0 billion in another—apartments. During this time together we have done hundreds of transactions when accounting for property purchases, sales, refinances, recapitalizations, and loan restructures (yes, we have had our challenges). We were able to avoid losses in our manufactured housing and apartment investments while generating annual returns in excess of 13 percent compounded, after accounting for all fees for the apartment communities we have sold. This represents a total of 55 properties (approximately $1.5 billion in value) sold since 1996, as of this writing.

In addition, real estate has some unique tax advantages from which our investors have benefitted. We almost always utilize tax-deferred exchanges when we sell a property. This allows investors to roll over their appreciated investments without having to pay tax, affording them much more pre-tax wealth at work than the equivalent stock market investor who would pay capital gains taxes on the profit and then reinvest after-tax proceeds in the next investment. Further, if the investors don’t ever need to sell, their heirs inherit the asset at the market value upon the investors’ death. All of the deferred taxes accrued due to the depreciation (a noncash expense) that sheltered some of the income and distributions received over the years are now eliminated. It’s a pretty powerful wealth preservation tool that will be quantified later with a very interesting and compelling example from the results of one of our investors. I also happen to appreciate it, since the bulk of my net worth is represented by real estate.

I have not only had incredible partners in business and in life—including my wife of twenty-five years (as of this writing), who has more common sense and gumption than anyone I know—but some amazing sages as well, most of whom I have never met. These include the thoughts and writings of a number of brilliant philosophers, investors, economists, writers, and songwriters. This is why I have applied to this book the subtitle Transforming Wisdom into Wealth. The phrase is a reference to alchemy and the philosopher’s stone, that elusive tool said to transform lead into gold, life into eternal youth, flaws into perfection.

I have always been fascinated by finding patterns in numbers and connecting seemingly unrelated events. I have used such connections to form unconventional insights that help us stay off the mountain while the conditions for an avalanche are forming. They also help us find the courage to get back on while lift tickets are being dramatically discounted because so many skiers are still digging themselves out and the owners of the resort are under great financial pressure.

The first rule of investing is to avoid situations where one is at great risk of losing one’s capital permanently. One is then free to focus on the rewards. During times of uniform investor euphoria, it is imperative for investors to pay attention when disastrous conditions are forming. If they are unable or unwilling to do so, then they should try to have their money with those who are. Devastating losses, which may never be recouped, can result for those who become complacent or stay at the party too long.

The NASDAQ is still below 5,000, nearly fifteen (as of this writing) years after reaching its peak in March 2000, while the Nikkei is more than 60 percent lower than it was in 1989. These events represent financial avalanches in which those who bought at the top are still digging themselves out. Investing has taught me the importance of avoiding catastrophic error in all aspects of life, and the most important way of doing this is by ruthlessly analyzing our contribution to past errors and where we are most susceptible to self-delusion or manipulation by others.

By tapping into such brilliant people as nineteenth-century philosopher Arthur Schopenhauer, Shakespeare, famed investor Charlie Munger, mythologist Joseph Campbell, economist John Maynard Keynes, legendary investors Warren Buffett and John Templeton, brilliant journalist and writer Walter Lippmann, Nobel Prize–winning physicist Richard Feynman, hedge fund titan George Soros, Jim Rogers (Soros’s former partner), Bob Dylan, Depression-era Federal Reserve chairman Marriner Eccles, and iconoc...

Table of contents

• Cover Page
• Title
• Copyright
• Dedication
• Acknowledgments
• Contents
• Part I. Preparing for the Munger Moment
• Part II. CWS’s Munger Moment
• Part III. Lessons Learned from This Long, Strange Trip
• WORKS CITED
• ABOUT THE AUTHOR
• INDEX